exv10w3



 








Exhibit 10.3




THE FASHION HOUSE HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEET

SEPTEMBER 30, 2005

(UNAUDITED)




	 	 	 	 	 
	ASSETS
	 	 	 	 
	Current assets:
	 	 	 	 
	Cash
	 	$	536,884	 
	Accounts receivable
	 	 	328,583	 
	Prepaid expenses
	 	 	120,152	 
	Total current assets
	 	 	985,619	 
	Property and equipment, net
	 	 	306,284	 
	Deposits
	 	 	47,373	 
	 
	 	$	1,339,276	 
	LIABILITIES AND STOCKHOLDERS’ DEFICIT
	 	 	 	 
	Current liabilities:
	 	 	 	 
	Accounts payable and accrued expenses
	 	$	480,118	 
	Accrued payroll and related
	 	 	295,245	 
	Due to factor
	 	 	210,475	 
	Accrued interest
	 	 	228,382	 
	Convertible notes payable, net of debt discount of $321,000
	 	 	229,000	 
	Note payable to stockholder
	 	 	751,000	 
	Warrant liability
	 	 	712,000	 
	Total current liabilities
	 	 	2,906,220	 
	Commitments and Contingencies

	 	 	 	 
	
Stockholders’ deficit:
	 	 	 	 
	Common stock, no par value; 100,000,000 shares authorized; 18,733,737 shares issued and outstanding
	 	 	4,080,894	 
	Accumulated deficit
	 	 	(5,647,838	)
	Total stockholders’ deficit
	 	 	(1,566,944	)
	 
	 	$	1,339,276	 






See accompanying notes to financial statements.







1









 








THE FASHION HOUSE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

(UNAUDITED)




	 	 	 	 	 	 	 	 	 
	 	 	2005	 	 	2004	 
	Net sales
	 	$	1,202,192	 	 	$	4,362,098	 
	 
	 	 	 	 	 	 	 	 
	Cost of sales
	 	 	1,096,169	 	 	 	2,799,496	 
	Gross profit
	 	 	106,023	 	 	 	1,562,602	 
	Operating expenses:
	 	 	 	 	 	 	 	 
	Selling, general and administrative
	 	 	2,168,444	 	 	 	1,234,684	 
	Payroll and related
	 	 	756,034	 	 	 	365,875	 
	Royalties
	 	 	421,563	 	 	 	312,116	 
	Total operating expenses
	 	 	3,346,041	 	 	 	1,912,675	 
	Loss from operations
	 	 	(3,240,018	)	 	 	(350,073	)
	Other income (expense):
	 	 	 	 	 	 	 	 
	Gain on sale of license
	 	 	—	 	 	 	1,350,000	 
	Interest expense
	 	 	(1,122,410	)	 	 	(117,841	)
	Total other income (expense), net
	 	 	(1,122,410	)	 	 	1,232,159	 
	Net income (loss)
	 	$	(4,362,428	)	 	$	882,086	 
	Basic and diluted net income (loss) per share
	 	$	(0.29	)	 	$	0.07	 
	Weighted
average shares outstanding:
	 	 	 	 	 	 	 	 
	Basic and diluted
	 	 	14,826,416	 	 	 	13,041,862	 






See accompanying notes to financial statements.






2









 








THE FASHION HOUSE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

(UNAUDITED)




	 	 	 	 	 	 	 	 	 
	 	 	2005	 	 	2004	 
	Net sales
	 	$	455,867	 	 	$	1,407,856	 
	 
	 	 	 	 	 	 	 	 
	Cost of sales
	 	 	294,623	 	 	 	792,119	 
	Gross profit
	 	 	161,244	 	 	 	615,737	 
	Operating expenses:
	 	 	 	 	 	 	 	 
	Selling, general and administrative
	 	 	707,951	 	 	 	476,662	 
	Payroll and related
	 	 	375,486	 	 	 	135,306	 
	Royalties
	 	 	74,688	 	 	 	108,227	 
	Total operating expenses
	 	 	1,158,125	 	 	 	720,195	 
	Loss from operations
	 	 	(996,881	)	 	 	(104,458	)
	Other income (expense):
	 	 	 	 	 	 	 	 
	Gain on sale of license
	 	 	—	 	 	 	1,350,000	 
	Interest expense
	 	 	(504,864	)	 	 	(69,470	)
	Total other income (expense), net
	 	 	(504,864	)	 	 	1,280,530	 
	Net income (loss)
	 	$	(1,501,745	)	 	$	1,176,072	 
	Basic and diluted net income (loss) per share
	 	$	(0.09	)	 	$	0.09	 
	Weighted
average shares outstanding:
	 	 	 	 	 	 	 	 
	Basic and diluted
	 	 	16,207,951	 	 	 	13,041,862	 






See accompanying notes to financial statements.





3










 







THE FASHION HOUSE HOLDING, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

(UNAUDITED)




	 	 	 	 	 	 	 	 	 
	 	 	2005	 	 	2004	 
	CASH FLOWS FROM OPERATING ACTIVITIES:
	 	 	 	 	 	 	 	 
	 
	Net income (loss)
	 	$	(4,362,428	)	 	$	882,086	 
	Adjustments to reconcile net income (loss) to net cash used in operating activities:
	 	 	 	 	 	 	 	 
	Depreciation and amortization
	 	 	33,604	 	 	 	24,670	 
	Gain on sale of license
	 	 	—	 	 	 	(1,350,000	)
	Amortization of estimated fair value of beneficial conversion features
	 	 	631,000	 	 	 	—	 
	Amortization of estimated fair value of warrants
	 	 	358,000	 	 	 	—	 
	Changes in operating assets and liabilities:
	 	 	 	 	 	 	 	 
	Accounts receivable
	 	 	(124,691	)	 	 	(2,674	)
	Prepaid expenses
	 	 	(96,988	)	 	 	(104,359	)
	Deposits
	 	 	(34,021	)	 	 	(4,311	)
	Accounts payable and accrued expenses
	 	 	271,185	 	 	 	168,405	 
	Settlement payable
	 	 	(135,000	)	 	 	135,000	 
	Accrued payroll and related
	 	 	12,284	 	 	 	—	 
	Accrued interest
	 	 	158,640	 	 	 	117,637	 
	Net cash used in operating activities
	 	 	(3,288,415	)	 	 	(133,546	)
	CASH FLOWS FROM INVESTMENT ACTIVITIES:
	 	 	 	 	 	 	 	 
	Purchases of property and equipment
	 	 	(191,739	)	 	 	(125,768	)
	Proceeds from sales of license
	 	 	—	 	 	 	1,350,000	 
	Net cash provided by (used in) investing activities
	 	 	(191,739	)	 	 	1,224,232	 
	CASH FLOWS FROM FINANCING ACTIVITIES:
	 	 	 	 	 	 	 	 
	Proceeds from note payable to stockholder
	 	 	370,000	 	 	 	141,634	 
	Repayments of notes payable to stockholder
	 	 	(161,000	)	 	 	—	 
	Proceeds from convertible notes payable
	 	 	1,750,000	 	 	 	—	 
	Repayments of convertible notes payable
	 	 	(625,000	)	 	 	—	 
	Advances from factor
	 	 	1,020,263	 	 	 	960,836	 
	Payments to factor
	 	 	(911,614	)	 	 	(971,965	)
	Proceeds from the issuance of common stock, net of issuance costs of $486,210
	 	 	2,402,540	 	 	 	—	 
	Net cash provided by financing activities
	 	 	3,845,189	 	 	 	130,505	 
	Net increase in cash
	 	 	365,035	 	 	 	1,221,191	 
	Cash, beginning of the period
	 	 	171,849	 	 	 	10,639	 
	Cash, ending of the period
	 	$	536,884	 	 	$	1,231,830	 
	SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
	 	 	 	 	 	 	 	 
	Cash paid during the period for interest
	 	$	38,324	 	 	$	50,100	 
	Cash paid during the period for income taxes
	 	$	—	 	 	$	—	 






See accompanying notes to financial statements.







4









 








THE FASHION HOUSE HOLDING, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

(UNAUDITED)




	 	 	 	 	 	 	 	 	 
	 	 	2005	 	 	2004	 
	Supplemental Schedule of Noncash Investing and Financing Activities:
	 	 	 	 	 	 	 	 
	 
	 	 	 	 	 	 	 	 
	Issuance of common stock on conversion of debt and accrued interest
	 	$	579,554	 	 	$	—	 
	Estimated fair value of beneficial conversion features of certain convertible notes payable
	 	$	788,000	 	 	$	—	 
	Estimated fair value of warrants issued in connection with certain convertible notes payable
	 	$	522,000	 	 	$	—	 
	Estimated fair value of warrants issued in connection with private placement
	 	$	190,000	 	 	$	—	 






See accompanying notes to financial statements.







5









 








THE FASHION HOUSE HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)




NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



The accompanying condensed consolidated financial statements have been prepared in accordance with
the Securities and Exchange Commission’s (“SEC”) regulations for interim financial information.
Accordingly, they do not include all of the disclosures required by accounting principles generally
accepted in the United States of America (“GAAP”) for complete financial statements. In the opinion
of management, all adjustments (which consist only of normal and recurring adjustments) considered
necessary for a fair presentation have been included. The results of operations for the three and
nine month periods ended September 30, 2005 are not necessarily indicative of the results that may
be expected for the entire fiscal year.




Organization and Nature of Operations



On August 19, 2005, TDI Holding Corporation (“TDI”) entered into an agreement of Plan of
Reorganization (“Merger”) with The Fashion House, Inc. (“TFH”) in a tax free share exchange under
Section 368(a)(1)(B) of the Internal Revenue Code of 1986, as amended. Immediately prior to the
Merger (after considering the stock split), TDI had 1,006,344 shares of common stock issued and
outstanding and no preferred stock issued and outstanding. Pursuant to the Merger, all of the
outstanding shares of TFH’s common stock were exchanged into 14,114,200 shares of TDI common stock.
Immediately after the Merger, TDI had 15,120,544 shares of common stock issued and outstanding and
no shares of preferred stock issued and outstanding. In addition, pursuant to the Merger, TFH paid
$325,000 to TDI, which TFH expensed as acquisition costs, which is included in selling, general and
administrative expenses in the accompanying condensed consolidated statements of operations during
the period ended September 30, 2005.



Immediately after the Merger, the officers and directors of TDI resigned and the management of TFH
controlled such positions; therefore, effecting a change of control. As a result, the transaction
was recorded as a “reverse merger” whereby TFH was considered to be the accounting acquirer as it
retained control of TDI after the Merger. Simultaneously with the Merger, TDI changed its name to
The Fashion House Holdings, Inc. (hereafter referred to as the “Company”).



TFH was incorporated under the laws of the State of Delaware on April 11, 2002 and commenced
operations on January 1, 2003. TFH designs, develops and markets women’s dress footwear with an
emphasis on celebrity appeal, style, quality and fit. The Company targets the moderate to
premium-priced categories of the women’s footwear industry and implements its business model by
licensing recognized brand names.




Basis of Presentation



The condensed consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America.




Principles of Consolidation



These consolidated financial statements include the accounts of the Company and its wholly owned
subsidiary. All material intercompany accounts have been eliminated in consolidation.




6









 









THE FASHION HOUSE HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)




NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued




Use of Estimates



The preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and reported amounts of revenues and expenses during the reporting
periods. Significant estimates made by management include, among others, collectibility of
receivables, recoverability of long-lived assets and valuation of warrants to purchase common stock
and deferred tax assets. Actual results may differ from these estimates under different assumptions
or conditions.




Going Concern



The financial statements have been prepared on a going concern basis which contemplates the
realization of assets and the satisfaction of liabilities in the normal course of business. The
Company incurred a net loss of $4,362,428 for the nine months ended September 30, 2005, had a
working capital deficit of $1,938,601 and an accumulated deficit of $5,731,838 at September 30,
2005. These factors raise substantial doubt about the Company’s ability to continue as a going
concern. The ability of the Company to continue as a going concern is dependent on obtaining
sufficient debt or equity financing in the very near future and achieving profitable operations.
These financial statements do not include any adjustments that might be necessary if the Company is
unable to continue as a going concern.




Risks and Uncertainties




Credit Risk



The Company maintains its cash accounts in financial institutions. Accounts at these institutions
are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $100,000. At September 30,
2005, the Company has cash balances which exceeded the insured limit by $401,207.



The Company assigns the majority of its trade accounts receivable to a factor (see Note 2), however
the Company maintains the credit risk with respect to collection of these amounts. The Company
makes sales to customers not approved by its factor at its own risk and monitors the outstanding
receivable balance. At September 30, 2005, the Company determined that no allowance for doubtful
accounts was necessary.



The Company operates in an industry that is subject to intense competition and government
regulation. The Company’s operations are subject to significant risks and uncertainties including
financial, operational, technological, regulatory and other risks associated with an operating
business, including the potential risk of business failure.




Merchandise Risk



The Company’s success is largely dependent upon its ability to gauge the market trends and the
tastes of its targeted consumers and provide merchandise that satisfies consumer demand. Any
inability to provide appropriate merchandise in sufficient quantities in a timely manner could have
a material adverse effect on the Company’s business, operating results and financial condition.



The Company purchases substantially all of its inventory from two vendors. The loss of either of
these vendors could have a material adverse effect on the Company’s cash flow and financial
position.




Inventories



Inventories will consist of returned merchandise from customers or unsold goods held by the trading
company at a public warehouse in excess of sixty days. As noted below, the Company has no inventory
on hand at June 30, 2005 and December 31, 2004.




7









 









THE FASHION HOUSE HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)




NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued




Property and Equipment



Property and equipment are stated at cost. Depreciation of equipment is provided for by using the
straight-line method over the estimated useful lives of the related assets, which are 5 years for
machinery and equipment and 7 years for furniture and fixtures. Expenditures for maintenance and
repairs are charged to expense as incurred; additions, renewals and betterments are capitalized.
When property and equipment are retired or otherwise disposed of, the related cost and accumulated
depreciation are removed from the respective accounts, and any gain or loss is included in
operations.




Long-Lived Assets



In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, the Company evaluates the carrying value of long-lived
assets for impairment whenever events or change in circumstances indicate that such carrying values
may not be recoverable. The Company estimates the future undiscounted cash flows derived from an
asset to assess whether or not a potential impairment exists when events or circumstances indicate
the carrying value of a long-lived asset may not be recoverable. Am impairment loss is recognized
when the undiscounted future cash flows are less than its carrying amount. If assets are considered
to be impaired, the impairment to be recognized is measured by the amount by which the carrying
amount exceeds the fair value of the assets. At September 30, 2005, the Company’s management
believes there is no impairment of its long-lived assets. There can be no assurance, however, that
market conditions will not change or demand for the Company’s products or services will continue,
which could result in additional future impairment of long-lived assets.




Fair Value of Financial Instruments



The Company’s financial instruments consist of cash, accounts receivable, accounts payable and
accrued expenses, due to factor, accrued interest and convertible notes payable. The carrying value
for all such instruments approximates fair value at September 30, 2005. The fair value of the note
payable to stockholder is not determinable as the borrowings are with a related party.




Revenue Recognition



Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) 101, Revenue Recognition , as
amended by SAB 104, outlines the basic criteria that must be met to recognize revenue and provide
guidance for presentation of revenue and for disclosure related to revenue recognition policies in
financial statements filed with the Securities and Exchange Commission. Management believes that
the Company’s revenue recognition policy conforms to SAB 104.



We evaluate the criteria of the Financial Accounting Standards Board (“FASB”) Emerging Issues Task
Force (“EITF”) Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, in
determining whether it is appropriate to record the gross amount of revenue and related costs or
the net amount earned as commissions. The Company is the primary obligor, is subject to inventory
risk, has latitude in establishing prices and selecting suppliers, establishes product
specifications, and has the risk of loss as it relates to the ultimate collection of accounts
receivable and cargo losses. Accordingly, the Company’s revenue is recorded on a gross basis.




8









 








THE FASHION HOUSE HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)




NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued



The Company utilizes a trading company (see Note 2) to provide trade finance and factoring services
in connection with the manufacture, distribution and sale of the Company’s products (referred to
hereinafter as the “Goods”) to customers. The trading company issues letters of credit in favor of
the manufacturers at the request of the Company, and in accordance with the information provided in
such requests. The trading company imports and delivers Goods, as instructed by the Company, to a
public warehouse and pays the manufacturers for the cost of Goods and the related costs covered by
the requests.



Goods are held by the Company at a public warehouse on a consignment basis. The Company arranges
and maintains the Goods while in its possession at its expense. The trading company has title to
the Goods when shipped from the manufacturer and in the public warehouse. The trading Company is
paid for the Goods upon their sales and shipment to the Company’s customers. Goods that remain
unsold in the public warehouse on or after sixty days from receipt are billed by the trading
company and title to the goods is transferred to the Company. For all Goods purchased, the
Company’s charged cost plus 4% by the trading company. There were no unsold Goods billed by the
trading company and purchased by the Company during the three and nine months ended September 30,
2005 and 2004.



Revenue is recognized upon shipment of goods from the public warehouse to the customers, which is
when title transfers to the customers. The trading company approves credit to the customers and
factors the sale. The trading company charges the Company 2.5% of the sales which are factored. For
sales that are not factor approved, the Company purchases Goods from the trading company and sells
the Goods directly to the customers.



The Company has title to all Goods returned by customers to the public warehouse. At September 30,
2005, returned inventory was not material to the overall financial statements.



Shipping and handling costs billed to the customers are recorded in sales. Shipping and handling
costs as incurred by the Company are recorded in cost of sales.




Advertising



The company expenses advertising costs, consisting primarily of placement in multiple publications,
along with design and printing costs of sales materials, when incurred. Advertising expense for the
nine month periods ended September 30, 2005 and 2004 amounted to $38,039 and $60,529, respectively.




Income Taxes



The Company determines its income taxes under the asset and liability method in accordance with the
SFAS No. 109, “Accounting for Income Taxes.” Under the asset and liability approach, deferred
income tax assets and liabilities are calculated and recorded based upon the future tax
consequences of temporary differences by applying enacted statutory tax rates applicable to future
periods for differences between the financial statements carrying amounts and the tax basis of
existing assets and liabilities. Generally, deferred income taxes are classified as current or
non-current in accordance with the classification of the related asset or liability. Those not
related to an asset or liability are classified as current or non-current depending on the periods
in which the temporary differences are expected to reverse. Valuation allowances are provided for
significant deferred income tax assets when it is more likely than not that some or all of the
deferred tax assets will not be realized.




9









 








THE FASHION HOUSE HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)




NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued




Earnings Per Share



The Company uses SFAS No. 128, Earnings Per Share for calculating the basic and diluted income
(loss) per share. Basic income (loss) per share is computed by dividing net income (loss) by the
weighted average number of common shares outstanding during the period. Diluted income (loss) per
share is computed similar to basic income (loss) per share. All potentially dilutive shares,
935,000 as of September 30, 2005 have been excluded from diluted loss per share, as their effect
would be anti-dilutive for the period then ended. There were no potentially dilutive shares during
the period ended September 30, 2004.




Basic and diluted (loss) income per common share is computed as follows:




	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	 	 	Nine Months Ended September 30,	 
	 	 		 	 	2005	 	 	Per-	 	 		 	 	2004	 	 	Per-	 
	 	 	Loss	 	 	Shares	 	 	Share	 	 	Income	 	 	Shares	 	 	Share	 
	 	 	(Numerator)	 	 	(Denominator)	 	 	Amount	 	 	(Numerator)	 	 	(Denominator)	 	 	Amount	 
	Basic EPS
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	(Loss) income available to common stockholders
	 	 	(4,362,428	)	 	 	14,826,416	 	 	$	(0.29	)	 	 	882,086	 	 	 	13,041,862	 	 	$	0.07	 
	 
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	Effect of Dilutive Securities
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	None
	 	 	—	 	 	 	—	 	 	 	 	 	 	 	—	 	 	 	—	 	 	 	 	 
	 
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	Diluted EPS
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	Loss available to common stockholders
	 	 	(4,362,428	)	 	 	14,826,416	 	 	$	(0.29	)	 	 	882,086	 	 	 	13,041,862	 	 	$	0.07	 






	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	 	 	Three Months Ended September 30,	 
	 	 	
	 	 	2005	 	 	Per-	 	 		 	 	2004	 	 	Per-	 
	 	 	Loss	 	 	Shares	 	 	Share	 	 	Income	 	 	Shares	 	 	Share	 
	 	 	(Numerator)	 	 	(Denominator)	 	 	Amount	 	 	(Numerator)	 	 	(Denominator)	 	 	Amount	 
	Basic EPS
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	Loss (income) available to common stockholders
	 	 	(1,501,745	)	 	 	16,207,951	 	 	$	(0.09	)	 	 	1,176,072	 	 	 	13,041,862	 	 	$	0.09	 
	 
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	Effect of Dilutive Securities
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	None
	 	 	—	 	 	 	—	 	 	 	 	 	 	 	—	 	 	 	—	 	 	 	 	 
	 
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	Diluted EPS
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	Loss available to common stockholders
	 	 	(1,501,745	)	 	 	16,207,951	 	 	$	(0.09	)	 	 	1,176,072	 	 	 	13,041,862	 	 	$	0.09	 






Stock-Based Compensation



In December 2004, the FASB issued SFAS No. 123 (revised 2004) (“SFAS 123(R)”), “Share-Based
Payment,” to provide investors and other users of financial statements with more complete and
neutral financial information by requiring that the compensation cost relating to share-based
payment transactions be recognized in financial statements. That cost will be measured based on the
fair value of the equity or liability instruments issued. SFAS 123(R) covers a wide range of
share-based compensation arrangements including share options, restricted share plans,
performance-based awards, share appreciation rights, and employee share purchase plans. SFAS 123(R)
replaces SFAS No. 123, and supersedes APB No. 25. SFAS No. 123, as originally issued in 1995,
established as preferable a fair-value-based method of accounting for share-based payment
transactions with employees. However, that Statement permitted entities the option of continuing to
apply the guidance in APB No. 25, as long as the footnotes to financial statements disclosed what
net income (loss) would have been had the preferable fair-value-based method been used. Small
business issuers will be required to apply SFAS 123(R) as of the first interim or annual reporting
period that




 









 







begins after December 15, 2005. The Company will apply SFAS 123(R) to all stock-based employee
compensation arrangements. There have been no options issued to employees as of September 30, 2005.



Stock-based awards to non-employees are accounted for using the fair value method in accordance
with SFAS No. 123 and EITF Issue No. 96-18, Accounting For Equity Instruments That Are Issued To
Other Than Employees For Acquiring, Or In Conjunction With Selling Goods Or Services . All
transactions in which goods or services are the consideration received for the issuance of equity
instruments are accounted for based on the fair value of the consideration received or the fair
value of the equity instrument issued, whichever is more reliably measurable. The measurement date
used to determine the fair value of the equity instrument issued is the earlier of the date on
which the third-party performance is complete or the date on which it is probable that performance
will occur.




10









 









THE FASHION HOUSE HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)




NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES




Derivative Financial Instruments



In connection with the issuance of warrants with convertible notes payable (see Note 5), the
Company is required to file a registration statement within 75 days of issuance of the convertible
notes and have such registration statement declared effective no later than 180 days following the
Merger (the “Effectiveness Deadline”). In addition, the Company will be required to issue the
holders of convertible notes a number of warrants equal to 123,750 for each subsequent 30 day
period that such registration statement has not been filed. Also, the Company will be required to
issue the holders of convertible notes a number of warrants equal to 123,750 for each 30 day period
following the Effectiveness Deadline. In addition, the Company is required to include the warrants
issued to the placement agent for the private placement in such registration statement (see Note
6). The Company determined that the registration rights are an embedded derivative instrument
pursuant to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , as
amended. Under the provisions of EITF Issue No. 00-19, Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” the accounting
treatment of these derivative financial instruments requires that the Company record the
derivatives at their fair values as of the inception date of the note agreements and at fair value
as of each subsequent balance sheet date. Any change in fair value will be recorded as
non-operating, non-cash income or expense at each balance sheet date. If the fair value of the
derivatives is higher at the subsequent balance sheet date, the Company will record a
non-operating, non-cash charge. If the fair value of the derivatives is lower at the subsequent
balance sheet date, the Company will record non-operating, non-cash income.



At September 30, 2005, there are derivative liabilities of $712,000 related to the warrants with
registration rights. Due to the close proximity of the balance sheet date to the issuance date of
the warrants, there was no change in valuation of the related derivatives.



Warrant-related derivatives were valued using the Black-Scholes Option Pricing Model with the
following assumptions during the nine months ended September 30, 2005: dividend yield of 0%; annual
volatility of 62%; and risk free interest rate of 3.0%.




Beneficial Conversion Feature



The convertible feature of certain convertible notes payable (see Note 5) provides for a rate of
conversion that is below market value. Such feature is normally characterized as a “beneficial
conversion feature” (“BCF”). Pursuant to EITF Issue No. 98-5 (“EITF 98-5”), Accounting For
Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratio and EITF Issue No. 00-27, Application of EITF Issue No. 98-5 To Certain Convertible
Instruments, the fair values of the BCFs have been recorded as a discount from the face amount of
the respective debt instrument. The Company is amortizing the discount using the effective interest
method through maturity of such instruments. The Company will record the corresponding unamortized
debt discount related to the BCF and warrants as interest expense when the related instrument is
converted into the Company’s common stock.




11









 








NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES




Recent Accounting Pronouncements



In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, an amendment of APB
29, Accounting for Nonmonetary Transactions . This Statement’s amendments are based on the
principle that exchanges of nonmonetary assets should be measured based on the fair value of the
assets exchanged. Further, SFAS 153 eliminates the narrow exception for nonmonetary exchanges of
similar productive assets and replaces it with a broader exception for exchanges of nonmonetary
assets that do not have commercial substance. Provisions of this statement are effective for fiscal
periods beginning after June 15, 2005. The adoption of this statement is not expected to have a
material impact on the financial statements.



In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections . SFAS 154 replaces
APB 20, Accounting Changes and SFAS 3, Reporting Accounting Changes in Interim Financial Statements
and establishes retrospective application as the required method for reporting a change in
accounting principle. SFAS 154 provides guidance for determining whether retrospective application
of a change in accounting principle is impracticable and for reporting a change when retrospective
application is impracticable. The reporting of a correction of an error by restating previously
issued financial statements is also addressed. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not
expect the adoption of this statement to have a material impact on the financial statements.




NOTE 2 — ACCOUNTS RECEIVABLE FACTORING



On February 1, 2003, the Company signed a factoring agreement with Madison Administrative Services,
Inc. (“MAS”), a New York corporation. Under the factoring agreement, MAS charged the Company a
factoring fee of 1% of the gross invoice amount of each account receivable, subject to a minimum
annual fee of $9,000. MAS, to the extent of any financing provided, held a security interest in all
assets of the Company over the term of the factoring agreement. During the nine months ended
September 30, 2005 and 2004, factoring fees charged by MAS totaled $3,033 and $39,878,
respectively. During the three months ended September 30, 2005 and 2004, factoring fees charged by
MAS totaled zero and $8,958, respectively.



In November 2004, the Company terminated its factoring activities with MAS and signed a conditional
mutual release with MAS on April 6, 2005, whereby the Company agreed to pay MAS $135,000, of which
$50,000 was due upon signing and $85,000 due in June 2005. The Company remitted the $85,000 balance
in July 2005.



On November 14, 2004, the Company signed a factoring agreement with Itochu International, Inc.
(“Itochu”), a New York corporation. Under the factoring agreement, the Company is charged a
factoring fee of 1.5% of the gross invoice amount, with no minimum annual fee, and all invoices are
subject to approval by Itochu. Itochu, to the extent of any financing provided, holds a security
interest in all assets of the Company over the term of the factoring agreement. Either party may
terminate the factoring agreement by providing 60 days written notice. In accordance with the
agreement, Itochu will advance the invoice amount, but at no time will the outstanding balance of
advances exceed $500,000.




At September 30, 2005, the following summarizes the
Company’s accounts receivable and related balances:




	 	 	 	 	 
	Receivables assigned to factor
	 	$	288,127	 
	Advances from factor
	 	 	(210,475	)
	 
	 	 	 
	Amounts due from factor
	 	 	77,652	 
	Unfactored accounts receivable
	 	 	40,456	 
	Allowances for returns and allowances
	 	 	—	 
	 
	 	 	 
	 
	 	$	118,108	 
	 
	 	 	 






NOTE 3 — NOTEPAYABLE TO STOCKHOLDER



From time to time, the Company borrows funds from a founding stockholder for working capital
purposes, which bear interest at 8% per annum and are due in January 2006. As of September 30,
2005, outstanding borrowings totaled $769,000, and accrued interest totaled $147,669.




12









 









THE FASHION HOUSE HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)




NOTE 4 — COMMITMENTS AND CONTINGENCIES




Licensing Agreements



For the rights to use trademarks, the Company has entered into licensing agreements with various
licensors. The agreements enable the Company to sell products using the name of the licensor in
return for a licensing fee based upon sales of the product using the licensor’s name.



The Company acquired rights to use four trademarks as evidenced by licensing agreements entered
into with Nicole Miller, Richard Tyler, Tyler and Oscar by Oscar de la Renta, which expire on March
3, 2009, November 26, 2007, November 26, 2007 and June 30, 2010, respectively. Under these
licensing agreements, the Company agreed to pay the greater of between 3% and 8% of net sales of
the licensed products or guaranteed minimums ranging from $54,600 to $210,000 per annum. The
licensor may terminate the licensing agreements upon event of default, as defined.



In 2004, the Company sold the rights to use the Nicole Miller trademark under its licensing
agreement through March 2009 to an unrelated third party for $1,350,000 and realized a gain of
$1,350,000.



Minimum annual guaranteed royalty payments on the above licenses are as follows:




	 	 	 	 	 
	Years ending December 31,
	 	 	 	 
	2005
	 	$	429,000	 
	 
	 	 	 	 
	2006
	 	 	593,000	 
	2007
	 	 	832,000	 
	2008
	 	 	1,007,000	 
	2009
	 	 	1,384,000	 
	Thereafter
	 	 	510,000	 
	 
	 	$	4,825,000	 






Indemnities and Guarantees



The Company has made certain indemnities and guarantees, under which it may be required to make
payments to a guaranteed or indemnified party, in relation to certain actions or transactions. The
Company indemnifies its directors, officers, employees and agents, as permitted under the laws of
the State of Delaware. In connection with its facility leases, the Company has indemnified its
lessors for certain claims arising from the use of the facilities. Additionally, the Company
indemnifies its factor and licensors under the factoring and license agreements, respectively,
against certain claims as a result of the violation of any law. The duration of the guarantees and
indemnities varies, and is generally tied to the life of the agreement. These guarantees and
indemnities do not provide for any limitation of the maximum potential future payments the Company
could be obligated to make. Historically, the Company has not been obligated nor incurred any
payments for these obligations and, therefore, no liabilities have been recorded for these
indemnities and guarantees in the accompanying balance sheet.




Litigation



The Company is, from time to time, involved in various legal and other proceedings which arise in
the ordinary course of operating its business. In the opinion of management, the amount of ultimate
liability, if any, with respect to these actions will not materially affect the financial position
or results of operations of the Company.




13









 









THE FASHION HOUSE HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)




NOTE 5 — CONVERTIBLE NOTES PAYABLE 



In April and May 2005, the Company issued convertible notes payable totaling $625,000, bearing
interest at 11 percent per annum (the “11% Notes”). The notes and accrued interest were due through
August 2005, as amended. In addition, the principal and accrued interest on the 11% Notes are
convertible into shares of the Company’s common stock at a conversion price equal to $0.80 per
share. The Company recorded a BCF of $375,250 in connection with the conversion feature of the
notes payable during the nine months ended September 30, 2005 and amortized $375,250 to interest
expense in the accompanying statement of operations during such period. In connection with the
issuance of the 11% Notes, the Company issued warrants to purchase an aggregate of 687,500 shares
of the Company’s common stock (see Note 6), including a warrant to purchase 62,500 shares of the
Company’s common stock issued in connection with an extension of the maturity date. In August 2005,
the Company repaid such amounts, including accrued interest of $35,392. The holder of the 11% Notes
has the right to purchase up to 50% of any equity security, including convertible debt, to be
issued by the Company on the same terms as such securities are offered to other parties through May
2008.



In July 2005, the Company issued a convertible note payable totaling $550,000, bearing interest at
11 percent per annum (the “July 11% Note”). The notes and accrued interest are due in January 2006.
In addition, the principal and accrued interest on the July 11% Notes are convertible into shares
of the Company’s common stock at a conversion price equal to $0.80 per share. The Company recorded
a BCF of $269,000 in connection with the conversion feature of the notes payable during the nine
months ended September 30, 2005 and amortized $112,000 to interest expense in the accompanying
statement of operations during such period. In connection with the issuance of the July 11% Notes,
the Company issued warrants to purchase an aggregate of 550,000 shares of the Company’s common
stock (see Note 6). At September 30, 2005, the balance of the July 11% Notes is $269,000, net of
unamortized debt discounts of $157,000 and $164,000 related to the BCF and warrants, respectively.



In June and August 2005, the Company issued convertible notes payable totaling $575,000, bearing
interest at 6 percent per annum (the “6% Notes”). The notes and accrued interest were due at the
earlier of the initial closing of the Company’s private placement (see Note 6) or June 2006. In
addition, the principal and accrued interest on the 6% Notes were convertible into shares of the
Company’s common stock at a conversion price equal to $0.80 per share. The Company recorded a BCF
of $143,750 in connection with the conversion feature of the notes payable during the nine months
ended September 30, 2005 and amortized $143,750 to interest expense in the accompanying statement
of operations during such period. In conjunction with the initial closing of the Company’s
reorganization (see Note 1), the entire balance of $575,000 of 6% Notes, and $4,554 of accrued
interest, was converted into 724,443 shares of the Company’s common stock in accordance with the
related agreements.




14









 








THE FASHION HOUSE HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)




NOTE 6 — EQUITY TRANSACTIONS 




Common Stock



On June 1, 2005, the Company entered into an agreement with Brookstreet Securities Corporation
(“BSC”), a NASD member investment banker based in Irvine, California, as its placement agent and
financial consultant to sell newly issued common stock at $1.00 per share for a total offering from
a minimum of 2,500,000 shares to a maximum of 4,600,000 shares, in order to raise minimum capital
of $2,175,000 to maximum capital of $4,002,000, net of expenses. The Company agreed to pay BSC an
8% retail sales commission, a 2% non-accountable marketing allowance and a 3% non-accountable
expense allowance. BSC also received warrants to purchase 433,313 shares of the Company’s common
stock at an exercise price of $1.00 per share.



On August 19, and September 7, 2005, The Company completed the initial closings of the minimum
amount of its private placement through BSC with the sale of 2,888,750 shares of its common stock
receiving proceeds of $2,402,540, net of commissions, fees and expenses of $486,210.




Warrants



During the nine months ended September 30, 2005, the Company issued warrants to purchase an
aggregate of 1,237,500 shares of the Company’s common stock in connection with the issuance of
convertible notes payable (see Note 5), with fair values totaling $522,000 as determined under SFAS
No. 123 and recorded such as a debt discount and warrant liability (see Note 1). These warrants
vested upon grant, have exercise prices of $0.80 and expire on various dates through July 2008. As
of September 30, 2005, $358,000 has been amortized to interest expense.



During the nine months ended September 30, 2005, the Company issued warrants to purchase an
aggregate of 433,313 shares of the Company’s common stock to BSC in connection with the initial
closings of the Company’s private placement (see above), with fair values totaling $190,000 as
determined under SFAS No.123. These warrants vested upon grant, have exercise prices of $1.00 and
expire through September 2010. The fair value of the warrants has been classified as a liability
and an offset to the proceeds received in the private placement.










15